Leaky Building Exclusions: Court of Appeal says wait and see

• It remains to be determined if a watertightness exclusion wholly excludes the insured’s liability for watertightness and other building defects or if the insured’s liability is to be allocated between covered and uncovered defects.
• Underwriters should consider if particular exclusions require different formulation of the excluded liabilities or if consistency with other exclusions is preferable.
• Court of Appeal warns that policy interpretation questions may not be suited to strike out.

In 2013 the Body Corporate and unit owners of the Waterfront Apartments in Napier issued proceedings against the Napier City Council (Council) and other defendants alleging that their properties had been constructed with watertightness, fire protection and structural defects. The Council was alleged to have been negligent in exercising its functions under the Building Act 2004 in issuing building consents, building inspections and issuing Code Compliance Certificates. The Council settled the Waterfront Plaintiffs’ claims in February 2019.

The Council claimed indemnity from Riskpool.¹

Riskpool declined the Council’s claim on the grounds that the policy’s watertightness exclusion meant it did not cover “liability for Claims alleging or arising directly or indirectly out of, or in respect of … the failure of any building or structure to meet or conform to the requirements of the New Zealand Building Code… in relation to leaks, water penetration, weatherproofing, moisture, or any water exist or control system.” (clause 13(a)).

The Council sought declaratory relief. Riskpool applied to strike out the proceeding relying on the exclusion.

In the High Court² Riskpool argued that “Claim” in the insuring clause and the watertightness exclusion referred to the Waterfront Plaintiffs’ entire claim against the Council. The proper interpretation of the policy was that the entirety of their claim against the Council was excluded, including any liabilities for non-watertightness defects. This was because the Waterfront Plaintiffs had made one demand for compensation articulated in one Statement of Claim. That claim alleged or arose directly or indirectly out of or in respect of watertightness defects.

Hinton J did not accept Riskpool’s interpretation. She considered the exclusion envisaged multiple Claims arising out of the failure of any building, and therefore different defects could amount to different Claims for the purposes of the exclusion. This was consistent with the insuring clause which suggested that there may be more than one “Claim” arising out of a single negligent act.³ Further, the intention of the parties must have been to exclude liability on the part of Riskpool in respect of watertightness defects and not to exclude liability in respect of other defects, whether these are pleaded in one statement of claim or not.⁴ Otherwise, the policy would not serve its commercial purpose and there would be little indemnity available to the Council for non-watertight defects.

It was a matter for trial for the Council to establish distinct qualifying (insured) building code breaches, each with a distinct loss.⁵

Although Hinton J did not place any weight on the decision, she noted in Body Corporate 326421 v Auckland Council Gilbert⁶ J had approached a leaky building exclusion by examining each defect to determine if it was excluded (an “allocation” approach).

The Court of Appeal dismissed Riskpool’s appeal but differed from Hinton J’s reasons.

The Court observed what it described as “a number of curiosities” about the drafting of the exclusion clauses in the policy as a whole. These variously excluded “amounts of any claim”, “legal liability” for certain events, “negligent acts, errors or omissions” of certain types, “claims” in a general sense and “Claims” in a defined sense. It could not be certain from the wording of the exclusion whether the parties had intended “Claim” to mean the entirety of the Plaintiffs’ claim against the Council or its divisible parts.⁷ Extrinsic and contextual evidence was needed to determine this question.

The Court expressed concern about being asked to decide the exclusion’s meaning in a vacuum. More generally, it sounded a warning about whether strike out is the appropriate way to decide policy interpretation questions where extrinsic evidence is fundamental to interpreting the contract, referring to its previous decisions in Vero Liability Insurance Ltd v Symphony Group Ltd⁸ and Trustees Executors Ltd v QBE Insurance (International) Ltd.⁹

The meaning of the watertightness exclusion is therefore to be determined at trial.

Insurers may be reconsidering their appetite for building industry risks given the expansion of leaky building litigation to include structural and fire claims.

Although the Court of Appeal did not address this issue, it is likely that an “allocation” approach to mixed claims involving watertightness and other defects will be preferred. Unless there is a clearly expressed intention to the contrary in the policy, allocation gives effect to the objective of the exclusion without rendering the liability cover meaningless. This will mean that insureds or insurers facing mixed claims need to determine which defects fall within the available cover and what liabilities flow from each covered or excluded defect.

The Court of Appeal’s judgment signals two clear warnings for liability insurers:

• Underwriters should consider the wording used to preface the exclusion, not just the subject matter of the excluded risk. The policy should make it clear where the exclusion applies to the whole or part of a particular Claim, liability or risk. Internal consistencies within an insurance policy matter. The Court will look at the wording afresh and wonder whether differences in wording are “deliberately differentiated drafting” or indicative of “a bit of a mess”. This is particularly important when non-standard wordings and endorsements are used.
• The Court will be reluctant to construe insurance clauses, particularly exclusions, in the factual vacuum that comes with a strike out application. Insurers may be better off seeking determination as a preliminary question so that extrinsic evidence may be placed before the Court.

1. A mutual trustee company established by the New Zealand Local Government Insurance Corporation Ltd which insures local authority members for certain liabilities
2. Napier City Council v Local Government Mutual Funds Trustee Ltd [2018] NZHC 2269
3. HC at [14]-[22]
4. HC at [28]
5. HC at [32]
6. Body Corporate 326421 v Auckland Council [2015] NZHC 862
7. CA at [31] to [38]
8. Vero Liability Insurance Ltd v Symphony Group Ltd [2000] NZCA 419
9. Trustees Executors Ltd v QBE Insurance (International) Ltd [2010] NZCA 608, 16 ANZ Insurance Cases ¶61-874

This publication is intended as a general overview and discussion of the content dealt with. It should not be used in any specific situation, in which case you should seek specific legal advice.